Global Economy Regains its Footing The global economy is regaining some of its footing, with recent economic and trade developments in the U.S. and China offering some comfort that the slowdown is easing.
Flash U.S. Composite PMI™
Private sector firms across the U.S. registered a slightly stronger expansion in business activity at the end of 2019. The upturn quickened to a five-month high as service sector growth accelerated and manufacturing conditions continued to improve.
Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 52.2 in December, up from 52.0 in November, to indicate the quickest rise in output since July. Nonetheless, the rate of growth was below the series trend and only moderate overall.
The increase in new business strengthened slightly in December, with service providers noting a second successive monthly upturn in demand. The expansion was also supported by a further solid rise in manufacturing new orders, albeit one that was slower than that seen in November. At the composite level, the rate of growth in private sector new business picked up to a five-month high.
Subsequently, firms increased their workforce numbers at a faster pace at the end of the year. Although employment growth softened among manufacturers, services companies recorded a quicker uptick in hiring due to greater client demand and larger workloads. Despite being only marginal, the overall rate of job creation was the quickest since July.
Indicative of a reduction in pressure on capacity, backlogs of work at private sector companies rose at a softer pace, increasing only fractionally overall.
Input prices increased at a sharper rate in December. Although historically subdued, the pace of cost inflation picked up across both monitored sectors. Notably, goods producers recorded the fastest rise in cost burdens since March. Firms also increased their output charges, with selling prices rising at the quickest rate since February.
Encouragingly, business confidence picked up among private sector firms, with the level of optimism rising to the highest since June.
The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index registered 52.2 in December, up from 51.6 in November. Though only modest, the figure signalled the fastest rise in service sector output since July.
Although the increase in new business remained historically muted, the rate of expansion quickened, with companies indicating the fastest rate of new order growth for five months. Firms also registered a renewed rise in export orders at the end of 2019, following four consecutive monthly declines.
Consequently, employment rose marginally for the second month running as firms expanded their staffing numbers to meet greater workloads.
Stronger new business growth also resulted in an uptick in output expectations among service providers. The degree of confidence was the most robust since June.
Meanwhile, the rate of input price inflation remained relatively subdued in December. Nonetheless, the pace of charge inflation outpaced the rise in cost burdens.
Manufacturers noted a broadly similar expansion in December as was seen in November, as signalled by only a slight dip in the IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) to 52.5 from 52.6 in November. Nevertheless, the overall improvement in operating conditions was one of the strongest in 2019.
Manufacturing sector growth was supported by further expansions in output and new orders, with the upturn in the latter remaining solid overall. Although rates of increase eased in each case, growth remained more robust than those seen earlier in the year.
Goods producers continued to expand their workforce numbers amid efforts to reduce pressure on capacity. At the same time, output expectations improved to their strongest since June.
Meanwhile, cost burdens rose at the fastest pace since March as firms noted ongoing pressure from suppliers due to tariffs. However, manufacturers increased their factory gate charges at a sharper pace in December as they sought to partially pass-on higher costs to clients.
Chris Williamson, Chief Business Economist at IHS Markit
(…) The brighter news needs to be caveated, as the overall rate of economic expansion signalled by the surveys remains well below that seen this time last year, commensurate with GDP rising at an annualised rate of just over 1.5%. Importantly, however, the welcome signs of improvement help to ward off recession risks and should keep the Fed on hold in the coming months. (…)
The Eurozone economy closed out 2019 mired in its worst spell since 2013, with businesses struggling against the headwinds of near-stagnant demand and gloomy prospects for the year ahead.
The ‘flash’ IHS Markit Eurozone Composite PMI® remained unchanged at 50.6 for a third successive month in December, running just above the 50.0 neutral level to indicate only very modest growth of output across the manufacturing and service sectors for a fourth consecutive month.
The December reading rounds off a fourth quarter in which output rose at the weakest pace since the economy pulled out of its downturn in the second half of 2013. The PMI is indicative of GDP growing at a quarterly rate of just 0.1%.
There are scant signs of any imminent improvement. New order growth remained largely stalled and job creation has almost ground to a halt, down to its lowest for over five years as companies seek to reduce overheads in the weak trading environment and uncertain outlook. Employment rose in December at the slowest rate since November 2014.
Weak jobs growth also in part reflected ongoing subdued optimism about prospects for the year ahead. Although up on the lows seen in the late-summer and autumn, expectations for future output dipped slightly in December, continuing to run at one of the lowest levels recorded since 2013.
Companies’ concerns once again centred on geopolitical uncertainty, notably including Brexit-related disruption and US trade wars, alongside more general concerns about slowing global economic growth in 2020.
The December malaise was once again led by manufacturing, where output slumped at the fastest rate since October 2012, having now fallen for 11 straight months. New orders placed at factories fell for a fifteenth successive month, the rate of decline re-accelerating after having eased in the prior two months. Manufacturers cut jobs at an increased rate in the face of falling demand, culling headcounts for an eighth successive month and to the greatest extent since October 2012.
There was better news from the service sector, where business activity and inflows of new work both grew at the fastest rates since August, although in both cases the rates of expansion remained modest by historical standards, and below the averages seen in 2019. Job creation in the service sector eased further as a result, down to the second-lowest recorded over the past three years.
The concern remains that, while service sector growth remains encouragingly resilient in the face of the manufacturing downturn, any further softening of the labour market could cause weakness to spill over.
By country, France continued to provide a key support to growth in the single currency area, but Germany remained in a mild downturn, fuelled by a steepening manufacturing recession. Growth in the rest of the region continued to run at the slowest for six years.
Germany’s steep manufacturing downturn has added to the chance of its economy contracting slightly in the fourth quarter, but France is enjoying a more resilient performance, providing a key area of support to help keep the eurozone growing.
Our colleagues in the European economic forecasting team expect eurozone GDP growth to have slowed from 1.9% in 2018 to 1.2% this year, weakening further to a seven-year low of 0.9% in 2020, when a bottom will hopefully have been reached. Growth should in fact start to pick up again during 2020, barring any further setbacks, as recent stimulus feeds through – aided by further action. We expect a further 10 basis points reduction in the ECB’s deposit facility rate (currently -0.50%) in the new year.
However, while we see recession risks as having eased in recent months, risks to the outlook remain skewed to the downside. Concerns include larger spill-overs from manufacturing to services and households, US tariffs, an oil price spike, uncertainty over Brexit and increased volatility in global financial markets. Furthermore, the political climate in many member states is not conducive to growth-enhancing economic reforms. While pressure is likely to build for additional fiscal stimulus, room for manoeuvre is limited by high debt burdens.
Boeing to Suspend 737 MAX Production Boeing said it would suspend production of its 737 MAX jetliner, marking an escalation of the crisis facing the giant plane maker that will ripple through the global aerospace industry.
The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo strengthened during December. The index rose to 76, up 7.0% m/m and by roughly one-third y/y. The index was the highest level for the economic expansion. (…) Over the past 15 years, there has been a 70% correlation between the y/y change in the home builders index and the y/y change in new plus existing home sales.
The index of present sales conditions rose 9.1% to 84 (37.7% y/y) after easing to 77 in November. The index of expected conditions in the next six months increased 1.3% (29.5% y/y) to 79, up for the third straight month. The index measuring traffic of prospective buyers rose 7.4% to 58 (34.9% y/y) and equaled the expansion high.
Regional readings were mixed this month. They indicated a 25.9% increase (40.4% y/y) in the Midwest to 73, which was just shy of the expansion high two years ago. In the South, the index gained 2.7% (26.2% y/y) to 77, a new high. Offsetting these increases was a 9.4% decline (+61.1% y/y) to 58 in the Northeast. The index for the West also fell 2.4% (+27.7% y/y) and reversed its November rise.
British Pound Drops on Risk of No- Deal Brexit European stocks were lower, with London’s mid-cap FTSE 250 down 1.4%, on fresh concerns the U.K. may break its ties with the European Union at the end of next year without a trading agreement in place.
SENTIMENT WATCH
(…) Analysts at Bank of America Merrill Lynch, led by strategists Michael Hartnett, described the market as “primed for Q1 2020 risk asset melt-up,” with the Federal Reserve and the European Central Bank still providing ample support to portions of the market and economy that have shown some signs of softness.
UBS Global Wealth Management Chief Investment Officer Mark Haefele said that a partial Sino-American trade resolution contributes mightily to the bullish thesis that a number of strategists have adopted. “This could unlock further upside for equity markets, driven by an improvement in business confidence and a recovery in investment,” Haefele wrote.
It is important to note that the a so-called melt-up is considered by market pundits as the end phase of an asset bubble and is usually, but not always, followed by a significant downturn in stock values.
The U.S. economy currently seems to be reasonably sound, assuming the consumer delivers (see yesterday’s Daily Edge). China?
By Fathom Consulting:
(…) Our China Momentum Indicator (CMI 2.0), an alternative gauge of economic activity in the country started the year at 5.1%, and reported a continuous downward spiral, with the latest figure posting 4.1%. The official GDP measure also slowed, with the Q3 figure hitting the lower bound of the PBOC target for growth at 6%.
(…) the slowdown in China’s economic activity is greater than can be attributed to the drag from trade tensions alone. (…) we find that the deteriorating global trade environment accounts for around two-thirds of the slowdown in our China Momentum Indicator since end 2017. The rest can be accounted for by domestic structural issues, such as poor allocative decisions, excess capacity, and the rising incidence of non-performing loans. But rather than transition the economy away from this old-style growth model, China has doubled down — cutting lending rates and allowing local governments to issue special bonds as capital for major investment projects, all the while, propping up inefficient and loss-making industries. This is illustrated in the chart below, which reports that in Qinghai around 40% of all industrial enterprises are now loss making. (…)
In order to shore up growth in a sustainable manner China needs to rebalance its economy away from the old growth engine of investment and manufacturing and focus on more consumer-led growth. 2019 has shown that domestic consumption in China has failed to offset the slowdown in private investment, an essential mechanism for efficient rebalancing. If the PBOC were to respond by implementing further fiscal transfers to promote a better distribution of wealth, this might boost consumption. We will have to wait and see whether it is a ‘New Year, New China’, but we at Fathom are forecasting more of the same. As the economic outlook weakens further, China will find it difficult to resist falling back on those old, tried-and-tested methods to push up short-term growth. We expect this to be to the detriment of a sustainable long-run growth path.
And about those trade deals:
Andy Rothman, Investment Strategist at Matthews Asia
(…) In an interview over the weekend, Lighthizer said that the Chinese government has committed, in writing, to dramatically raise the level of its imports from the U.S. “Overall, it’s a minimum of 200 billion dollars. Keep in mind, by the second year, we will just about double exports of goods to China, if this agreement is in place. Double exports. We had about 128 billion dollars in 2017. We’re going to go up at least by a hundred, probably a little over one hundred. And in terms of the agriculture numbers, what we have are specific breakdowns by products and we have a commitment for 40 to 50 billion dollars in sales. You could think of it as 80 to 100 billion dollars in new sales for agriculture over the course of the next two years. Just massive numbers.”
Massive, yes. But realistic? U.S. agricultural exports to China peaked in 2012 at US$26 billion, and none of the American agricultural experts I’ve consulted think it is possible to double that in the near future. My contacts in Washington say that the US$40 to 50 billion target was not based on a detailed assessment of China’s demand nor on the ability of American farmers to quickly expand output of soybeans and other crops. It was a politically expedient target.
The concept of quickly doubling the value of overall U.S. exports to China is equally dubious—even if the baseline is this year’s reduced level of US$88 billion for the first 10 months of this year. The historical peak was US$130 billion in 2017.
(Never mind the silliness of asking the Chinese government to commit to purchasing a set amount of American goods, irrespective of market conditions, at the same time the U.S. is pressing Beijing to establish a more market-driven economy. It is also worth noting that to date, China has declined to comment publicly on the sales targets. That will presumably change after the deal is signed.)
The uncertainty of how this will evolve, and how Trump will respond, means that this deal is unlikely to reassure American and Chinese CEOs, who have been deferring CapEx in response to uncertainty over the bilateral trade dispute. Removing that uncertainty was the negotiators’ top job, and they appear to have failed.
I would be delighted to be proven wrong in early January, when the deal is signed and details are published. Maybe there will be a clever plan to explain how China can buy so much American stuff so quickly. Maybe the details will show that the deal is in fact so good that, combined with NAFTA 2.0, it made last Friday, in Lighthizer’s words, “probably the most momentous day in trade history ever.”
- Economists question the US’ ability to ramp up exports to China to the levels that are in the “interim” deal. China (supposedly) agreed to buy $200 billion of US goods over the next two years above what it imported in 2017 (see story). This seems implausible. (The Daily Shot)
Source: Scotiabank Economics
Were China to actually import so much more from the U.S., who’s going to suffer?
The Ft reveals that “following discussions with the state department, industry representatives consulted lawyers, who told them that co-operating in such a way to shut out a global competitor could leave them open to being sued on antitrust grounds for acting as a cartel, and they backed out.” The commerce department also seeks “the power to block imports of any sensitive technology from a country dubbed a “foreign adversary”.
The FT says that “business leaders warn privately that such rules have been too widely drawn and could slow down large swaths of the global technology trade. “This is a huge power grab,” said one technology industry lobbyist.”
The WSJ:
(…) The shame is that in many respects the new deal is worse than Nafta, especially its bows to politically managed trade. The new deal tries to steer auto investment with new rules of origin that 75% of a car’s content must be made in North America, up from 62.5% under Nafta. This raises the cost of manufacturing, making North American products less competitive worldwide.
Also reducing North American competitiveness is a new rule mandating that 40% of an auto qualifying for tariff-free trade in the region has to be produced by workers earning $16 an hour. Mandating wage rates ignores the relationship between productivity and output and sets a bad precedent for future trade deals. Mr. Trump is using the mandate to make Mexico less competitive for car production.
The Trump Administration made these labor provisions worse in concessions to the AFL-CIO to get Speaker Nancy Pelosi to allow a vote on the House floor. The unions battered Mexico to allow a new enforcement process that will give American unions a new way to intrude in Mexican labor disputes.
If American activists complain about labor practices at a plant in Mexico, the U.S. Trade Representative can call for a multilateral panel to rule on the dispute. If the three-person panel rules in favor of the complaint, the U.S. can then impose tariffs in escalating stages. The risk is that this will produce a flood of new complaints.
North American auto production costs will also rise thanks to a new layer of protection for U.S. steel. The new deal mandates that 70% of steel used in North American vehicles must be made on the continent, and in seven years that share will have to include so-called slab steel that is now often imported before it is finished into specific steel products.
The U.S. auto companies say they can live with these higher costs, but other manufacturers may not. Some may find it makes more sense instead pay the 2.5% most-favored-nation tariff to import. Others will move full manufacturing to Mexico for vehicles and other products they export, reducing investment in the U.S.
Mr. Trump also bowed to the Pelosi Democrats’ demand to remove the 10-year protection for data exclusivity on biologics, a blow to one of America’s growth industries. This won’t change current U.S. law, which allows 12 years of protection, but Mexico allows only five and Canada eight. The new deal sends a signal that the world can loot American property rights—and American politicians will cheer them on. This is the opposite of “America first.” (…)
Our concern now is that the deal’s concessions to politically managed trade will become the new baseline for future negotiations.
Higher production costs and protection for politically influential industries won’t help workers. Senators will have to consider whether these bad precedents are worse than the benefit of saving most of the original Nafta.
Given already historically high valuations, a melt-up would also need rising earnings, or perhaps only rising earnings expectations. BAML provides support to that:
- Fund managers expect a rebound in corporate profits, which signals a recovery in manufacturing PMI. (The Daily Shot)
Source: BofA Merrill Lynch Global Research, @Callum_Thomas
Note the numerous “imperfections” on that chart.
Hard data says that, after 499 reports, Q3 earnings are down 0.4% but are expected to by up 10.3% one year from now. One year ago, Q3’19 earnings were expected up 12.1%.
Q4’19 earnings are expected down 0.2%, from +11.5% one year ago.
To paraphrase the twitter in chief, “we’ll see what happens”.
(…)
